In a "Washington memo" that (rightly) takes Mitt Romney to task for the vagueness of his tax plan, New York Times reporters Annie Lowrey and David Kocieniewski report that "many economists" believe "tax breaks are inefficient and even distort the economy." As I've said before, to the extent that they aim to change people's behavior (as opposed to rewarding them for what they would have done anyway), the whole point of tax breaks is to distort the economy, although their supporters might prefer a less negative-sounding verb. Lowrey and Kocieniewski warn, for instance, that eliminating the deduction for home mortgage interest, which accounts for about one-tenth of the $1 trillion in annual "tax expenditures," could mean that "housing prices will plummet just as that sector of the economy is starting to recover." That is another way of saying that the mortgage interest deduction artificially inflates home prices by subsidizing purchases (just as below-market-rate student loans artificially inflate the price of higher education). Likewise, although the tax-free status of employer-provided health benefits (the biggest tax expenditure) came about almost by accident (driven by wage and price controls during World War II and subsequent IRS rulings), the Obama administration decided not only to retain this feature but to reinforce it with tax breaks for employers, with the explicit goal of encouraging more job-based medical coverage (exactly the wrong way to go if you want to enhance portability and strengthen price signals). What is this bizarre system in which most people rely on their employers for health insurance (but not, say, life, auto, or home insurance) if not a tax-driven distortion of the economy?
Lowrey and Kocieniewski argue that Romney cannot cut tax rates by 20 percent, as he has promised, while retaining popular deductions such as the one for mortgage interest (as he also has promised), and still keep the net effect revenue neutral (as he has said he will do). William Gale, director of economic studies at the Brookings Institution, tells them, "The combination of stuff they've specified is not only impossible; it is impossible several times over." On Meet the Press yesterday, Romney was asked for "an example of a loophole that you will close." The best he could do was this: "I can tell you that people at the high end, high-income taxpayers, are going to have fewer deductions and exemptions." Aside from its lack of specificity, Romney's approach seems backward to me. Serious reform should start by eliminating the deductions, credits, and loopholes that have made the tax code such a headache-inducing mess and only then ask how much rates should be lowered to keep revenue about the same.